Monday, April 7, 2008

State of the Market - 4/7/08

A mixed day for the market today, as news of a capital infusion for banker Washington Mutual was greeted positively by traders at the open; however things got much worse in the second half of the session. The morning started with a small gap up which was sold, but buyers came in to give support and the indexes ran throughout the morning into the lunch hour, rarely pausing or pulling back. The only problem – volume. Volume was once again not there and tells us that big institutions were not putting money to work. As the afternoon started, stocks started selling off, and when they could not hold the morning lows, the selling increased. A few late bounces brought the indexes off their lows, and they finished mixed with the Nasdaq finishing marginally lower, and the S&P 500 finishing flat. Based on the afternoon selling, things could have been worse.

Intraday, I did notice we were starting to get overextended on a number of indicators that I use. The T2108 was quickly approaching the top of its range around 80 and the highs from October 2007, which coincidentally marked the start of this bear market. As I mentioned this weekend, stochastics are very overbought on all index charts. In my Market Monitor scans, the number of stocks that are up 50% in a month were at high levels as well, and these high levels often indicate a pullback is imminent. The VIX is still holding its long-term trend line as well. With heavy resistance approaching, I think it is best to watch yourself with new longs here. Putting this all together, I do not think we are heading into the earnings season in the best possible situation. On the contrary, we may be going in with the worst possible situation – overbought, with average to below-average volume on the way up, and facing major technical resistance. Not a recipe for success unless we have blow-out earnings across the board. So today’s action could be the start of a pullback in the major indices – the question is what type of pullback we get?

I do think we move at least a little lower here – I don’t know how much lower, and I still do respect that we have rallied and the potential for dip buyers to come out. Right now, that will be the key for me – how do we react during a pullback? We are in a confirmed rally, some stocks are making nice moves – if we pullback on lower volume and if buyers come in to buy any intraday dips, then that will be very bullish for the market and maybe we rally even more than I though we would originally. However, if we start seeing more days like today, that start strong and end weak, and if the volume rises on the pullback, then I think we will see that the bear market is back in force and we just had a typical bear market rally. I don’t know which of these outcomes we will see, and I will trade accordingly. If it’s the first option, then I will use tight stops on the shorts I entered today and look to take profits early. If it is the second option, I will add to my shorts on the way down as the selling increases. If for some reason we don’t pullback and just bust right through resistance, well, then this market would be much stronger than I think even the bullish of traders would be giving it credit for.

I decided to sell my WSCI this morning at $12.82 for an 18.8% gain. Of course, it went about a $1 higher later in the day, so it may have been a mistake to get rid of it, because it was not giving any sell signals other than the fact that it was oversold and is very extended right now, but with this market, I felt like protecting my profits would be a good idea. I will take that type of gain over a five day period any time, and I would still be interested in entering again on a pullback to the 9 day moving average if the market holds up. My only mistake was not adding to the position at all on Friday – it moved too quickly and I didn’t want to chase it. I also started a position in KOP in the morning but the breakout action was very poor and I was stopped out late in the afternoon. This is not the type of powerful move you want to see in a breakout, so I am not upset.

I also started some short positions in the afternoon based on what I mentioned above about a possible pullback and what I would call a “hunch”. I would much rather start my shorts here with a clear stop loss so close by in case I am wrong so I am taking the chance on FWLT, BIDU, DECK, and a few inverse ETF’s(SMN and FXP). They aren’t huge positions, but the charts show similar patterns – rallies up to previous resistance areas on lower volume. The BIDU short is probably the one I like least because of volume but $300 was support for a long time and now should act as heavy resistance – if it doesn’t, I will simply cover and get out with a small loss. A lot of the solar stocks look very bearish after today but I did not have the guts to short the two I was watching (STP and SPWR) and I also don’t want to get too short too quickly because I realize I can be very easily wrong here.

I will post these charts later along with some others that are interesting and worth watching. With earnings season beginning today, I think things will start getting very interesting. Bulls should be hoping for a few days to a week or so of quiet trading and even a slight pullback here. Bears should be hoping today’s afternoon reversal was a sign of things to come, and that we get some heavy selling over the next few days. Who knows which one it will be – probably a combination of the two that will make things extra confusing. Good luck.

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